Payments are one of the three fundamental tasks that the financial system undertakes, in addition to holding deposits and lending. Of the three, it’s arguably the most varied, complex, and important to the functioning of our modern economy.
Historically, payments have been mediated by private individuals, physical clearing warehouses, and even The Knights Templar. However, since the middle of the 20th century, payments rails have evolved on the back of technological innovations in communications, security, and storage to the point where governments consider payments technology critical to national infrastructure. The top global payments companies are valued at nearly one trillion dollars.
Effective payments enable effective commerce. From global trade networks to the self-checkout at the supermarket, a range of payment options are necessary to fulfil different needs. All these options have merits and limitations making it even more important to understand them in order to build the right payments experience for your customers.
What is a payment, anyway?
Intuitively, payments are a transfer of value from one person to another. In reality, there’s a wealth of complexity even in this basic definition.
- Value can mean many different things. For now, we’ll simplify this to mean “government-backed currencies”. But in reality it could mean any kind of asset that someone places value upon (see: UK gilts, fine art, cryptocurrencies, or Yapese Rai stones).
- “Person” could mean a “natural person” (i.e. a human being like you and me), or a legal person such as a company, partnership, or government. For our purposes, we’ll talk about all of these as “customers”, but be aware that different customer types can have very different needs.
- Payments don’t have to involve movement between different people. A large volume of payments are between different accounts held by the same person, particularly when that “person” is a large and complex legal entity, or group of legal entities. In modern banking, payments are not made between people, but rather between accounts that relate to one or many peoples. So, we’ll use “accounts” to refer to where funds are held, and as both the source and destination for payments.
- “From one person to another” gets significantly more complex if those persons (whether legal or natural) exist within different countries. In this post, we’ll only talk about domestic payments (i.e. within one country) as these make up the large majority of payments. We’ll address international payments in a future blog post.
Acknowledging all this complexity, and simplifying where possible, we can then ask the obvious question:
Why have different payment types?
Firstly, because of history. As technology has changed and become cheaper, new methods of offering payments have become commercially viable. Bulk payments systems like BACS are a product of batch-processing computer systems, whereas the Faster Payments Service (FPS) is a product of the real-time computing age. It is worth noting that some payment types (notably cards) have had to evolve throughout their lifespan to stay relevant and useful.
Secondly, because there are tradeoffs to be made when offering payments, and different customers and use cases have different needs. For example, BACS is super cheap but not as flexible as Faster Payments. It’s great for predictable batch payment like bills and salaries and might serve a customer that’s looking to cut operational costs.
On the other hand, Faster Payments are instant, but payments sent to the wrong recipient cannot be revoked. Once sent, another payment must be made to return an accidental payment. This may be a great option for smaller one-off payments.
Finally, because of changing use cases. E-commerce didn’t exist 40 years ago and so there were no payment rails designed to support it. Today, e-commerce is a huge part of the global economy and many payments companies, such as Stripe and Paypal, specialise in payments services that specifically cater to online businesses.
What are my options?
In deciding which payment rails will work for your business, you should consider factors such as speed, cost, customer experience, security, consumer protection, and the availability of data. Ultimately, your customer and business goals should be at the heart of your decision.
The table below compares the most popular payment rails in the UK based on these factors:
|Speed||Cost||Customer experience||Security||Legal rights and consumer protection||Availability of data
and value added services
|CHAPS||Fast - real-time irrevocable settlement
(This is one of the main features of CHAPS,
removing any settlement risk makes it ideal
for high value transactions
with less well-known parties)
|High - many banks charge £25+ per payment||Mixed - typically have to visit branch,
self-serve and digital capabilities
|High - often required to present ID in branch
(bad experience but high barrier to fraud)
|Low - immediate and irrevocable payment||Medium - rich transaction data
but no value-added services
|Faster Payments||Fast - real-time authorisation,
settlement - three times per day
|Low - typically pence per payment||Good - instant and available via banking apps or API||High - use of friction and checks such
as 2FA make it more secure
|Low - payments are irrevocable
(currently, there are fraud issues because of this,
which legislation is aiming to resolve soon)
|High - rich transaction data and services
e.g. payment initiation via Open Banking only
|BACS||Slow - three day settlement cycle||Very low - typically pence per payment||Good - able to set up recurring payments via payments||Medium - normally has some security built into
online experience, but out of scope of SCA
and can be set up via paper
|Medium - refund capability within Direct Debit scheme||Low - basic transaction data available,
no value-added services
|Cheques||Very slow - six day settlement cycle
(not including the time taken to send
the physical cheque to the recipient)
|Medium - processing fees vary significantly
but often around £1
|Bad - manual, requires effort from
both parties to write and cash,
multi-day clearing time, low security
|Low - no verification beyond a signature||Low - offers no consumer protection||Low - no transaction data except
for sender’s name
|Card (Debit/Credit)||Fast - real-time authorisation,
two day settlement cycle
|Very low - fees are offset by interchange
(interchange model offers incentive to banks
for accepting card payments, funded by merchants)
|Mixed - Highly optimised for in-person commerce,
but some challenges with online transactions
|High - enforced two-factor authentication
for large transactions or repeated transactions.
Reduced data vulnerability through tokenisation
|High - Chargeback infrastructure,
UK consumer rights protected for credit card purchases
|High - huge number of data enrichment,
data science,and overlay financial
crime services available
Most businesses will pick a mix of payment rails depending on the payment activities they frequently carry out and their customers’ needs.
Handling money transfers is complex, and any business that wants to facilitate such transactions needs a deep understanding of the payments rails available. In subsequent blog posts, we will discuss international payment rails and dive further into CHAPS, BACS, and Faster Payments.
For fintechs who want to offer payment services, Griffin will provide access to the UK’s payment rails.
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